Annuity Meaning, Definition & Types

What is Annuity?

An annuity is a financial agreement between you and an insurance company. You invest money upfront, either as a lump sum or through regular payments, and in return, the insurance company guarantees you a steady stream of income in the future. This income can start immediately (immediate annuity) or after a set growth period (deferred annuity). Annuities are popular retirement planning tools because they offer guaranteed income for life, which can help protect you from outliving your savings and market fluctuations. Additionally, they may come with tax benefits, such as tax-deferred growth and potentially tax-free portions of the payouts.

What are the Features of Annuity? 

Below mentioned are some of the features of annuities: 

• Guaranteed Income: Annuity plans offer a fixed, regular income stream after you deposit a lump sum or invest through regular premiums. This income is typically guaranteed for life, providing financial security during retirement.

• Flexibility: You can choose how you receive your income - monthly, quarterly, or annually. Some plans also offer a lump sum payout option.

• Safety: Annuity plans are considered low-risk investments as they are not directly linked to the stock market.

• Optional Riders: Some annuity plans offer additional riders like accidental death benefits, waiver of premium on permanent disability, etc., for more comprehensive coverage.

Different Types of Annuities

Different types of annuity payments option offered are:

1. Immediate Annuity

   There is no accumulation phase offered under this type of annuity plan. The immediate annuity plan starts offering the benefits right from the vesting age. In the immediate annuity plan, the policyholder needs to pay a lump-sum amount to the insurer, and the annuity payment starts immediately for a lifetime or a limited tenure.

2. Deferred Annuity

   Deferred annuities are pension plans where the annuity begins after a specific date. They can be further categorized into various types:

   • Fixed Annuity

     A fixed annuity plan ensures a guaranteed amount throughout the policy's duration. This predetermined amount is decided at the time of the policy’s purchase. The amount is guaranteed and remains unaffected by market fluctuations, providing stability and predictability to the annuitant.

   • Variable Annuity 

     Variable annuities invest your premiums in instruments like mutual funds or equities. The payouts depend on these investments' performance; higher fund performance yields greater returns, while poor performance may lead to lower payouts.

     During the annuity process, two critical phases play a role:

     • Accumulation Phase: This phase begins when you start investing and accumulating funds, starting from the date of your initial premium payment.

     • Vesting Phase: The vesting phase marks the start of receiving policy benefits in the form of a pension, typically after a set period or at retirement.

What are the Benefits of Different Annuities?

Below are the benefits of different annuities: 

Benefits of Immediate Annuities

• Immediate Payouts: These plans offer immediate payouts right after purchase, making them suitable for those needing instant income.

• Guaranteed Income Stream: Immediate annuity plans provide a guaranteed income stream during retirement, ensuring financial independence.

• Security: Provides peace of mind knowing you have a predictable income source for life.

• Protection Against Market Volatility: Immediate annuities are immune to market fluctuations, providing a fixed payout regardless of economic conditions.

Benefits of Deferred Annuities

• Tax-Deferred Growth: Deferred annuities allow for tax-deferred growth on earnings until withdrawals are made, helping delay the tax burden to a later stage.

• Guaranteed Income Stream: Like immediate annuities, deferred annuities provide a guaranteed income stream, ensuring financial stability during retirement and supporting post-retirement goals.

• Flexibility: Choose your payout start date to align with your retirement needs.

Note: T&C Apply 

How does an Annuity Work?

Here's how annuities work:

• Initial Investment: The process starts with the individual making a lump sum investment in an annuity plan. This investment can come from savings, retirement accounts, or other sources.

• Income Payments: After the investment, the annuity begins making payments to the individual on a future date or a series of dates. These payments can be structured to be received monthly, quarterly, annually, or as a lump sum, depending on the annuity's terms and the individual's preferences.

• Factors Affecting Payout: The amount of income payout is determined by several factors, including the duration of the annuity (tenure) and the type of annuity chosen.

• Lifetime or Fixed Period: An individual can choose to receive income payments for the rest of their life (lifetime annuity) or for a fixed period. The choice between these options depends on the individual's financial goals and retirement planning strategy.

• Type of Payout: The income received also depends on whether the individual has opted for a guaranteed payout (as in a fixed annuity) or a payout stream determined by the performance of the annuity's underlying investments (as in a variable annuity).

Tax Implications on Annuity

• Investment Stage: Premiums paid towards an annuity plan can be tax-deductible under Section 80C of the Income Tax Act. This can significantly reduce your taxable income in the year of investment.

• Maturity Stage: The tax treatment of payouts depends on the type of annuity:

  • Immediate Annuity:

    • Return of Purchase Price: The portion of the annuity payout that represents your original investment amount is generally tax-free.

    • Interest earned: The remaining portion of the payout, considered interest income, is taxable as per your income slab.

  • Deferred Annuity:

    • Annuity payouts: These are generally considered taxable income and taxed as per your income slab upon receipt.

    • Death Benefit: The death benefit paid to the nominee may be tax-free, depending on the specific plan and circumstances.**

  **Note: The tax implications mentioned on this page are based on current tax laws and regulations. Tax laws can change over time, and individual tax situations may vary. It is recommended to consult with a tax professional or financial advisor for personalized advice regarding tax implications related to investments, including annuities.

Why Should You Invest in an Annuity?

Consider an annuity if you prioritize these retirement needs:

• Guaranteed Income: Locks in a steady income stream for life, protecting against market downturns.

• Tax Advantages: Potential tax deductions on contributions and some tax-free payouts.

• Retirement Planning: Provides peace of mind knowing you have a reliable source of income after you stop working.

• Security for Spouse: Some plans offer spousal benefits to ensure your partner receives income even after you're gone.

It is a safety net for your retirement, offering predictable income and potential tax breaks.

Annuity Calculator

An annuity calculator is an online tool that helps you estimate the potential payouts or future value of an annuity based on your input. 

The annuity calculator asks for factors like your initial investment, desired payout amount, interest rate, and payout frequency. By inputting these details, you can understand how much income an annuity plan will generate or how much you'd need to invest to reach your desired retirement income. It's a helpful tool for planning your retirement and understanding how annuities might fit into your overall financial strategy.